美商藝電 (EA) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the Electronic Arts second-quarter fiscal 2004 earnings conference.

Today's call is being recorded.

For opening remarks and introductions, I would like to turn the call over to Ms. Karen Sansot, Director of Investor Relations.

Please go ahead, ma'am.

Thank you.

Good afternoon, and welcome to our second quarter fiscal 2004 earnings conference call.

Today on the call, we have Larry Probst, Chairman and Chief Executive Officer, John Riccitiello, President and Chief Operating Officer, and Don Mattrick, President of Worldwide Studios, and Warren Jenson, Chief Financial and Administrative Officer.

Before we begin, I would like to remind you that you may find copies of our SEC filings, this earnings release and a replay of the web cast at investor.EA.com.

Shortly after the call, we will post a copy of Warren's remarks on our web site.

Throughout this conference call, we will present both GAAP and non-GAAP financial results.

Non-GAAP results exclude charges associated with restructuring, asset impairment, other than temporary impairment of investments and affiliates, acquired in-process technology, and amortization of intangibles and the related tax effects.

A supplemental schedule to our earnings release provides a reconciliation of non-GAAP to GAAP measures.

All non-GAAP measures are provided as a complement to our GAAP results, and we encourage investors to consider all measures before making an investment decision.

All comparisons made in the course of this conference call are against the same period for the prior year unless otherwise stated.

During the course of this conference call, we may make forward-looking statements regarding future events and the future financial performance of the Company.

We caution you that actual events and results may differ materially.

We refer you to our most recent 10-K and 10-Q for a discussion of risk factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of October 22nd, 2003, and disclaim any duty to update them.

And now, I'd like to turn the call over to Warren.

Thanks, Karen.

Good afternoon, and thanks for joining us.

We are pleased to report another strong quarter.

Net revenue was 530 million, up 17 percent year-over-year.

The creative quality of our titles has never been better.

On the Playstation 2, Madden received a 95 MetiCritic rating, NCAA Football, a 94.

NASCAR NHL and Tiger had 85 plus ratings.

During the quarter, Madden sold in more than 3.6 million units, NCAA, Football more than 1.3 million units, Tiger, almost 800,000 units in just one week, and NASCAR Thunder and NHL each totaled over 500,000 units.

Our focus on quality and innovation continues to pay big performance dividends.

For the quarter, our gross margin was up 4 points to 59.7 percent.

Op. income was up 43 percent to 102 million, while our operating margin reached 19 percent.

Diluted earnings per share were up 47 percent to 50 cents per share.

Trailing twelve-month operating cash flow was 657 million, or $4.45 cents per share.

Our balance sheet continues to be strong.

Reserves in inventory are at appropriate levels.

Our cash and short-term investments balance, of 1.7 billion, equates to $11.68 per share.

On a trailing twelve-month basis, our return on invested capital was a strong 45 percent.

Our business continues to demonstrate an ability to produce stable and reliable results.

Trailing twelve-month revenue was 2.6 billion, up 24 percent year-over-year.

Trailing twelve-month gross margin was 58 percent, up 3 points.

Trailing twelve month non-GAAP operating margin was 23 percent, up 5 points.

On a trailing twelve-month basis, we had 23 platinum titles, up four titles year-over-year.

Before jumping into the specifics of the quarter, I would like to take a minute and talk about two drivers of our growth and performance reliability.

Specifically, continuously improving technology, coupled with innovative product development, and the impact of our leading marketing and sales organization.

Separately, each drives growth and helps promote performance stability and reliability.

But together, the whole is clearly greater than the sum of the parts.

Madden is a great example.

Madden NFL, the '95 rated title, is in its 14th season, and having its biggest year ever.

As of this past Monday, we estimate that our unit sell-through is up more than 56 percent year-over-year.

Over its lifetime, Madden sales have comfortably exceeded $1 billion in the U.S.

This franchise is in a class with Star Wars and James Bond, the only two movie franchises to exceed $1 billion at the U.S. box office.

The Madden franchise continues to innovate, taking advantage of what technology makes possible.

If you were to take a screenshot of Madden 2004 on the Playstation 2, you would find as many polygons in a single football as you do in an entire screenshot of Madden on the Playstation 1.

Madden's entertainment value is now mainstream.

ESPN uses Madden footage to diagram plays on its weekly NFL matchup show and Monday night countdown.

MTV aired a thirty-minute show making of the game, Madden NFL 2004.

It was one of MTV's highest rated shows that week.

Labels recognize Madden as an important place to launch ship .

Madden 2003 was a big part of launching Good Charlotte's the Young and the Hopeless Album.

It quickly shot to triple platinum.

This year, Outcast and Blink 182 debuted songs on Madden 2004.

Outcast's new album is number one on the charts.

Blink 182 releases its new album this November.

While it's great to talk about different statistics, TV ratings and record sales, there is a much bigger point to all of this.

At the end of the day, continuously improving technology, coupled with innovative product development and the best in marketing does three very important things.

Together they enhance the entertainment value of our titles, and therefore, very naturally expand the size of our market and the breadth of our reach.

Together, the combination is what reliably keeps our franchise properties fresh, relevant, and vibrant, growing year in and year out.

Together, they allow us to just flat-out sell more product.

While the results quarter-to-quarter will fluctuate based on release schedules, the reliability of our overall performance is grounded in proven franchise properties like Madden, like FIFA Metal of Honor, and our 20 other platinum titles that continue to get better every year as technology allows us to innovate, and as our marketing expands our breadth and reach.

This is our advantage and the driver of our growth.

For most entertainment companies, Digital is a cost play.

For us, it's our revenue strategy.

For the next few minutes, I'll focus my remarks in three areas.

First, I'll talk about our Q2 results, second, our market outlook for calendar 2003, and third, our financial guidance for the December quarter and fiscal 2004.

Following my comments, Larry, John, Don and I will open it up to your questions.

First our Q2 results.

During the quarter, we released 28 SKUs, six on Madden, three on NCAA, four on Tiger, four on NHL, four on NASCAR, two on Rugby, SIMS Double Deluxe on PC, SimCity 4 Deluxe on the PC, and three expansion packs on the PC for metal of Honor, Command and Conquer and SimCity 4.

Net revenue for the quarter was 530 million, up 17 percent, driven by sales of Madden, NCAA, Tiger Woods, NHL, NASCAR, SoCaliber 2, and PC expansion packs.

Catalog sales of the SIMS franchise, Metal of Honor frontline, and NBA Street Volume 2, also contributed.

As mentioned, Madden and NCAA broke new records for the September quarter.

Madden, in its 14th year, sold over 3.6 million units.

NCAA, in its 11th year, over 1.3 million.

NHL, Tiger and NASCAR also has strong sales, each selling over 500,000 units in under a month.

Year in and year out, our franchise properties continue to provide stability and predictability.

Geographically, our results were strong.

North American revenue was up 14 percent year-over-year, while international revenue was up 23 percent.

Absent a 14 million foreign exchange benefit, our international revenue would have been up 13 percent year-over-year.

Next, our revenue by platform.

Please keep in mind that our U.S. consul segment shares are based on NPD trist data from July to September.

While PC information is based on NPD TechWorld estimates for July and August.

In Europe, statement share information is based on EA estimates, as no service is comparable to NPD trist or NPD TechWorld are in place.

First on the Playstation 2.

PS/2 revenue was 42 percent of total revenue, or 221 million, up 39 percent year-over-year.

The increase was driven by strong sales of Madden, NCAA, Tiger Woods, NASCAR, and NHL.

In the U.S., our segment share was 42 percent, with six top 20 titles -- Madden, NCAA, Tiger Woods, NBA Street Volume 2, NASCAR Thunder, and Tiger Woods Golf.

In its first month of release, Madden became the number one selling PS/2 title of the year.

In Europe, our segment share was approximately 13 percent.

This quarter, our results were driven largely by our strong North American sports lineup.

On the PC, PC revenue was 18 percent of total revenue, or 93 million, up 13 percent year-over-year.

Sales were driven by the SIMS Franchise, Deluxe, Double Deluxe, and Superstar, and expansion packs for Metal of Honor, Command and Conquer and SimCity 4.

In the U.S., EA has seven of the top 20 PC titles and 19 percent segment share.

Titles occupying these top spots included SIMS Deluxe, Sims Superstar, Battlefield 1942, Command and Conquer Generals, SimCity 4, Sims Unleashed, and Madden.

In Europe, we estimate EA had four of the top 10 PC titles and 21 percent segment share.

The Sims Superstar, Sims Deluxe, Sims Unleashed, and Sims Holiday.

On Xbox -- sales represent 13 percent of total revenue or 69 million, up 83 percent year-over-year, driven by a larger installed base and more EA titles.

Our segment share was 27 percent with four of the top 20 titles -- Madden, NCAA, Tiger Woods, NBA Street Volume 2.

Madden and NCAA were the number one and number two selling football titles on this platform.

Madden had roughly four times the sales of our nearest competitor.

In Europe, we estimate our segment share to be approximately 14 percent.

On GameCube -- sales represented 5 percent of total revenue or 25 million, down 12 percent.

Sales were virtually flat in North America but down internationally.

Our segment share was 15 percent with three of the top 20 titles -- Madden, NCAA, NBA Street Volume 2.

In Europe, we estimate our segment share was approximately 13 percent.

Copub and distribution -- revenue was 17 percent of total revenue, or 92 million, down 4 percent year-over-year.

Sales of SoCaliber 2, Freedom Fighters, Battlefield 1942, and Aliens Vs.

Predators largely offset the typical prior-year comparison, driven by sales of Kingdom Heart .

Subscription services -- revenue, which includes subscription fees and packaged goods sales for online products, was 11 million, up 34 percent.

This increase was driven by this year's addition of the Sims Online, Growth and Beyond, and to a lesser extent, Club Pogo.

At the end of the quarter, we had 414,000 active players using our subscription services versus 265,000 a year ago and 338,000 in the previous quarter.

Growth was driven principally by the launch of Club Pogo, which ended the quarter with approximately 130,000 active players.

Of the 130,000 Club Pogo subscribers, approximately 60 percent are paying and the remaining 40 percent are registered, but in a free trial period.

While it is still very early, conversion from free trial to pay has been running about 90 percent.

EA SPORTS Nation is off to a great start, with 350,000 active accounts.

On average, EA SPORTS Nation has been adding approximately 30,000 new players per week.

This fall, we are launching several EA Games, and EA SPORTS big titles for the PS/2 online.

Metal of Honor, Need for Speed, SSX 3, Lord of the Rings, and Sims Bustin’ Out.

We will also begin experimenting with some pay for play tournament.

Moving onto the rest of the income statement -- gross profit in the quarter was 316 million, up 25 percent.

Gross margin was 59.7 percent, up 4 points year-over-year.

Margin improvement was driven by a higher percentage of consul and PC revenues versus distribution in the prior year.

Onto the bottom line.

Op income was 102 million versus 71 million in the year ago quarter, up 43 percent.

Operating margin was 19 percent in the quarter compared to 16 percent a year ago.

Net income was 77 million versus 50 million, up 52 percent.

Diluted earnings per share were 50 cents per share versus 34.

Our diluted share count ended at 154 million versus 147 a year ago.

Now the balance sheet.

Cash, short-term investments and marketables ended at 1.73 billion, up 112 million from the June quarter.

Gross accounts receivable were 330 million versus 265 million in the prior year, an increase of 65 million year-over-year.

The increase was a result of higher revenue and a more back-end loaded quarter.

Ending net inventory was 39 million versus 73 million a year ago.

In the quarter, we had several titles -- in the year ago quarter -- we had several titles that were due to ship in early October, which drove unusually high levels of inventory.

No one title currently represents more than $4 million of exposure.

Please note that these numbers now include pre-paid manufacturer royalties of 15 million in the current quarter, and $36 million in the prior year quarter as part of the cost of inventory.

We believe that this new classification is a preferred presentation.

It has no impact on our P&L.

Reserves against outstanding receivables totaled 127 million, up 1 million year-over-year.

Reserve levels were 14 percent as a percentage of trailing six-month net revenue versus 16 percent a year ago.

As a percentage of trailing nine-month net revenue, reserves were 9 percent versus 10 percent a year ago.

Our balance sheet is solid.

I will conclude my portion of today's call with our market outlook and financial guidance.

The big picture, you will hear three things from us relative to our guidance.

First, we're taking our numbers up for the year, even though some of our industry growth estimate are down slightly, given the absence of hardware price cuts.

Make no mistake though, this is a healthy marketplace.

Top-title pricing is solid, and you need look no further than our actual year-over-year performance to see what kind of shape EA is in.

As of Monday, we estimate our year-over-year sell-through to be as follows for a few titles.

Madden’s sell-through is up 56 percent in North America.

NCAA football is up 25 percent.

Tiger Woods Golf, up 132 percent.

NASCAR is up 18 percent.

NBA Live, up 96 percent.

And while industry PC sales are pressured, fiscal year to date, our reported PC revenue is up more than 9 percent.

Second, we expect to deliver record top and bottom line performance the back half this year.

We expect our third quarter to be bigger then all of fiscal 2001 on the top line, and all of fiscal 2003 on the bottom line.

Our Q3 gross margins should exceed 60 percent, and our operating margin will likely pass through 35 percent.

And third, we are bullish, not on just the short term, but also the long-term.

The delay in price reductions has a huge silver lining, making it possible that calendar 2004 is a bigger hardware year than calendar 2003.

And we haven't even started talking about the impact of the PSP .

Our estimates for calendar 2003 hardware and industry software sales are as follows.

Software prices -- we continue to expect the premium titles will hold the $49 price point, but that lesser titles will move toward 39.

In North America, we expect growth in software sales as follows.

For the PS/2, up 15 to 20 percent.

This is a decrease of 10 points in our range.

For the Xbox, up 20 to 25 percent -- no change here.

For the GameCube, up 25 to 30 percent based on recent price changes.

This is an increase of 10 points in our range.

PC, flat to down 5 percent.

This is a decrease of 5 points in our range.

By way of comparison again, our PC sales are up 9 percent for the six months of this year.

In North America, we expect the following hardware unit sales.

PS/2 unit sales of between 8 and 9 million units, down 1 million units from our previous range.

Xbox unit sales of between 2.5 and 3 million units -- no change here.

GameCube sales of between 2.5 and 3 million units, up 500,000 units.

In Europe, we expect the following hardware unit sales.

PS/2, between 7.5 and 8.5 million units, down 500,000 units.

Xbox, between 2 and 2.5 million units -- no change here.

GameCube, between 1.5 and 2 million units, again no change.

In total for both North America and Europe, our estimates for consul sales are down by 1 million units from our previous estimate.

This translates to a current generation installed base increase of 60 to 70 percent year-over-year.

Our estimates contemplate no further consul price reductions this year.

We expect our segment share gains to more than offset any impact of lower consul sales.

Our financial guidance.

Our guidance reflects our best thinking as of today.

There are plenty of unknowns and several things that could happen which could cause our actual results to be materially different.

We ask you to carefully consider our risk factors when evaluating these estimates.

I will cover our financial guidance in two parts.

First I will discuss the third quarter and then our outlook for the full year.

For the quarter ending December 31, we expect revenue to be between 1.425 billion and 1.475 billion, up 16 to 20 percent, and earnings per share to be between $2.30 and $2.40, up 36 to 42 percent year-over-year.

In Q3, we expect to ship 47 SKUs on 15 titles.

Lord of the Rings, Return of the King, on four platforms;

Harry Potter Quidditch on Five ;

Harry Potter and the Sorcerer's Stone on three;

Metal of Honor, Rising Sun on three platforms;

Metal of Honor Infiltrator on Game Boy Advanced;

Need for Speed Underground on five platforms;

Sims, Bustin’ Out on four;

Sims Makin' Magic on the PC;

SSX 3 on four platforms;

FIFA on six;

Total Club Soccer Manager on three;

NBA Live on four platforms;

March Madness on two;

Tiger Woods Golf on the Game Boy Advance; in Bond, Everything or Nothing, on Game Boy Advance.

Broadly, we expect the coming holiday season to look a lot like last year.

First, there will be winners and losers.

This market will once again favor the strongest titles.

Second, retailers will be highly discriminatory in how they buy and stock their shelves.

And finally, while we would never claim immunity from risk, we can tell you that, just like last year, we are ready, we love our titles, we love our marketing strategies.

We can safely predict this will be the biggest quarter in our history, both in terms of that top and bottom line.

For the full year, we expect revenue to be between 2.850 and 2.930 billion, up 15 to 18 percent.

This guidance is an increase from our previous range of between 2.8 and 2.9 billion.

Diluted earnings per share to be between 3.35 and 3.50, up 54 to 61 percent.

This is an increase from our previous full year guidance of 3.25 to 3.40 per share.

In the fourth quarter, we have three titles that could ship this fiscal year or in early fiscal 2005.

Those include Metal of, Honor Pacific Assault on the PC, The Sims 2.0 on the PC, and MVP Baseball on multiple platforms.

As you would expect, our guidance takes this into account.

Before opening the call up to your questions, I would to spend a couple of minutes talking about how we see things longer-term.

I will then conclude my remarks.

As we look ahead, we are decidedly optimistic.

Our glass is more than half full.

First, we think the real action in this cycle is yet to come.

In the PS/1 cycle, over 90 percent of all PS/1 consul and software unit sales took place at price points of 150 and below.

While we are not trying to say this cycle is only 10 percent of the way along, we know that price works.

As consul prices decline, volumes will accelerate.

As we said before, the delay in consul price reduction means next year could be the largest consul sales year in the cycle.

Time ratios continue to be strong.

We also see premium pricing holding much longer this cycle.

Second, we see several opportunities on the horizon which may represent clear upside that was not present during last cycle.

We are bullish on the PSP and think that Sony could hit a home run.

If we are right, its potential success could add billions into the software marketplace over its life cycle, and could prove to be a great bridge into the next consul cycle.

Needless to say, we will be ready for the launch.

We're also optimistic about online.

While we clearly expect that online will have its biggest impact in the next generation of consuls, we can see online being a source of incremental growth over the coming three to five years.

Third, globalization.

Our industry is still very, very young.

We are currently in the process of further building out our international direct sales force.

We now have EA teams in the Czech Republic, Hungary and Poland, and for the first time, a consul sales force in Japan.

This is an investment for the next five years of our growth and expansion.

There are 6 billion people in the world, and neither Sony, Microsoft, Nintendo, nor EA market entertainment to roughly 60 percent of this population.

There is a huge market opportunity in India, China, Latin America, and in Eastern Europe for our titles.

Right in front of us is an exploding Asia market.

If we play our cards right, this region of the world could start to look like another Europe within five years.

Finally, EA is reaching a point of critical mass in two important ways.

First, unit volumes for hit properties now create enormous bottom-line leverage.

You can see that in our results.

Looking forward, volume leverage is a real weapon to combat pricing pressures and higher development expense.

Second, we are committed as a company to making volume our friend, by driving process simplification and standardization into everything we do.

Just as Wal-Mart used volume to be faster and better than anyone, we want to do the same.

As we become more efficient, we can invest more in new technologies and in new talent, and at the same time, continue to deliver strong returns on our invested capital.

It's the best of both worlds.

As we look ahead, we are optimistic.

Our glass is decidedly more than half full.

I will now conclude with a few closing thoughts.

This was another record quarter for Electronic Arts.

We continue to demonstrate quality, innovation and marketing excellence.

As a result, Madden, NCAA Football, Tiger, NASCAR and NBA Live, are all off to the best launches in franchise history.

We are exactly where we want to be heading into the holidays.

We are number one globally, number one on the PS/2, and with big, recurring lasting franchises in place.

And by the way, we think our coming titles will blow you away.

Our guidance is up.

We are decidedly bullish on our longer-term outlook.

The delay in hardware price reductions has only one effect on EA; it makes fiscal 2005 that much bigger and better.

Based on our performance and confidence, we are pleased to announce that our Board of Directors has approved a two-for-one share split.

This is the fourth share split in the history of the company.

We are 110 percent focused on execution and taking nothing for granted.

Speaking from our EA college globally, we are dedicated to combining the best in creative content with the power of technology at the highest rates of return in the entertainment industry.

We are a digital entertainment pure play.

We look forward to reporting our results in the quarters ahead.

Operator, with that, we will open up to your questions.

Thank you very much. (OPERATOR INSTRUCTIONS).

We will take our first question from Michael P. Wallace of UBS.

A couple of questions.

First, Warren, could you talk about international sales?

If you take the currency out, I think you said it was up 13 percent.

Were there comparison issues there?

Was there a reason it was not up a little bit more overseas?

Second question, without a PS/2 price cut this year, how do you think price cuts play out?

Do we see 149 in the fall and then -- excuse me, in the spring -- something else in the fall?

How do you think the cuts kind of play out here the next two years.

Third question -- when do you get development kits for the PSP?

When do we see R&D starting to tick up for that?

And then the new consoles -- whether it is '05 or '06?

Mike, I will play master of ceremonies and first hand it to John and then Larry and then Don.

So this is John on the issue of international sales.

You've already read the numbers; they were strong for international in the quarter.

I think the biggest challenge in the quarter for us was frankly a lack of strong international titles coming from our studio in the quarter.

So for us, this quarter is about NCAA, about NASCAR, about Madden, which are very, very U.S.-focused titles.

We're very pleased to be able to lapse prior year when we're dealing with things with Metal of Honor.

So in general, I think, we're pleased with the results from the international side of the business in the quarter.

And where we really expect it to take off on the international side is in our Christmas quarter, when we've got huge international titles like Metal of Honor and Lord of the Rings.

So that is the pickup quarter for us on that side of the business.

Of course on the sports side internationally, we've got FIFA.

We will be shipping that title shortly; it's the best title in the history of the franchise.

We're feeling really, really good about that.

Mike, with regard to pricing, I think if nothing happens in the next two or three week period, because that's when retailers need to free their prices for their holiday promotions, then I think that Microsoft and Sony stay where they are currently, and if that were the case, then I would expect a price point reduction to about 149 around the time of E3 next year.

That would be my bet.

And in relation to the PST , obviously, we started assembling our tools and libraries growth inside of the company, working with Sony's team to deal with the technical specs.

And we're expecting early in 2004, receiving the development kits on that.

And is that enough time for fall launch?

Yes.

Thanks, Mike.

Shawn C. Milne from SoundView.

Thanks a lot.

Just wanted to go back to the PS/2 unit reduction.

Just working through the numbers, Warren, it seems like a pretty haircut on the software growth rate if you're only taking down PS/2 units by one million units, especially given some of the sell-through numbers that we're seeing on Madden NCAA.

I wonder if you could comment on that?

And then secondly, if you just look at the -- talk about the receivable number -- is it just Tiger going out late in the quarter that had the receivable number up?

Thanks.

With regard to the adjustments on Playstation 2 software in North America, we've taken a look at how the market has preformed year-to-date, and for the first nine months of the year, it's up 15 percent.

As you recall, last year, there was a blockbuster title in the market from Take 2 , Vice City, which did some pretty extraordinary numbers after its launch date.

I think it launched October 27.

So it was in the market a little over two months.

We don't see another title like that to drive the business.

So we are expecting that our titles are going to do extremely well.

Warren ticked off some of the key ones that we're shipping during the holiday season.

We think we're going to have a pretty significant marketshare relative to the last year.

There isn't a Vice City in the market.

So we have taken down the range.

And also the range that we gave you previously was contingent upon a hardware price point reduction of 149.

We don't see that happening now.

So we are trying to be as is conservative with the outlook as possible.

And then on the receivable question, this is solely a function of the fact that you have Madden, NHL Tiger, NCAA and Rugby shipping relatively late.

And that is what increased the receivables.

These are great receivables.

They are in great shape.

They will turn very quickly.

And Warren, just lastly on housekeeping -- did you give out a free cash flow target for fiscal '04 with CapEx?

Thanks.

No, we did not.

I can tell you we would expect CapEx to be around say, I would put it in the 60 to 70 million sort of category.

And we have not given out a free cash flow target.

I would tell you though that the next two quarters, we expect them to be decidedly positive.

Heath Terry with CSFB.

Thanks.

We again we saw another high watermark in terms of margins in the September quarter.

I'm wondering if you could -- gross margins anyway -- talk to us about where you think those can go in terms of how high they can get?

If we are talking about best of the cycle still yet to come, should we be thinking about numbers consistently around 60 percent or above on the gross margin line?

And then if you could also just talk a little bit about what your retail partners are telling you in terms of the holiday season -- how they are strategizing from a shelf space allocation standpoint and a product flow standpoint?

Heath, I will take the first part of the question and then John can jump in on the second.

On the margin side, starting first with gross margin.

I think one of the things you'll see on gross is that we are continuously doing more in-house development.

So I think that is going to naturally favor our gross margins, as you'll see more down in the R&D line.

We also think we get huge topline dividends out of doing that too.

And probably the biggest dividend in terms of the quality of the product, given what our studios can do.

So I think that will continue to be a benefit.

I think you have to keep in mind that through the coming years, there will be pricing pressures.

I think that's one of the things that productivity does for you, is help to offset any pricing pressure that one might feel.

I can also tell you that in thinking about pricing pressure, we think we will be impacted less than anybody else, really given the strength of our overall product portfolio.

On the bottom line, our objective is really very, very straightforward.

Our objective is to continue to drive productivity, process simplification, and standardization into everything we do.

We are at a point, scale-wise where this can become a real competitive advantage for Electronic Arts.

We are doing things, in terms of standardizing our tools and libraries, standardizing every process that we can think of within the company to drive efficiency.

What that allows us to do is invest more in our products, invest more in technology, invest more in talent.

At the same time, that then drives -- it is sort of circular -- it helps to drive our topline.

Heath, with regard to shelf space allocation, I think the retailers are going to focus on the companies and products that are strong companies and products that are supported well with television advertising and promotional efforts and marketing efforts.

You know, in our case, I think it's going to be titles like Madden, and NFL --- excuse me, NBA Live, and Metal of Honor, and Lord of the Rings, and Need for Speed Underground.

I think you're going to see a lot of retail focus on titles like that from EA.

With regard to product flow, I don't think they are going to be in the same trick bag as last year.

I think they're going to be careful about what they order, but I think they're going to go long on proven companies and proven titles.

Great.

Thanks.

Next we'll go to Edward Williams with Harris Nesbitt Gerard.

Just a couple of questions maybe geared towards Don.

As you're looking out to the PST, first of all, what do you think your market opportunity is there as it launches near fiscal '05 time period or maybe into calendar '05 even.

And also, what's your headcount right now in studio development?

And how do you see -- any of your development efforts changing -- maybe in terms of percent of revenue of games derived from internal studios?

Or what your target will be going forward?

I'm going to take the first part of that question.

We're pretty bullish about the prospects for PST.

To start, we have done extremely well during the initial launch period of any new hardware platform, particularly the hardware platforms from Sony.

I would expect to see that kind of performance from EA when PST launches.

We will focus on it;

I think we'll do well; and I think our marketshare will be reflective of that effort.

And in relation to our studio staff count, it's approximately 2500 people.

We're continuing to expand our internal studios, aggressively hiring and trying to use that hiring to increase our percentage of products by about 5 percent in the coming year.

Just a bolster, Don, a little bit; this is John -- responsible for the publishing side.

One of the great things about Don's growth in the internal studios -- titles built inside of EA are now typically getting 80, 85, sometimes 90, 95 ratings.

They are up much, much more -- they are much, much, more than any other publisher out there.

It is really easy to sell.

So internal studios typically give us products 85 to 95, and we can sell more of them.

What is the percent of revenue from internal studios right now?

It would be the majority of our revenue.

In terms of the number of titles, it's probably about 70 percent of the titles that we're publishing currently.

Okay.

I take it those are -- it's the biggest ones?

Yes.

So the percentage of revenue is probably higher than that.

Anthony Gikas with Piper Jaffray has our next question.

Couple of questions for you this afternoon.

What do you see in terms of revenue growth in the next fiscal year?

It looks like on the high end of your range, you're about 18 percent revenue growth this year.

Is that sustainable next year?

Or should we look at that as a couple hundred basis points below that?

Second, what gives you so much confidence that the PST platform is going to be, you know, so successful?

You sound particularly confident in that platform today.

And then looking out a little bit further, in terms of how do you grow the business, do you think there is some significant intellectual properties that are available in the market that you might be able to introduce in 2004 and 5?

And if so, are they new intellectual properties?

Or are they sort of spinoffs from existing properties like NFL Street?

Tony, why don't I take the first question and say nice try.

Looking ahead, we'll really get into guidance as we get closer into our next fiscal year.

We do like, however, the trends that we see presently.

Second question on the PSB ?

It's a great forum, and it's portable.

People who have been exposed to it think it's awesome.

And we've seen a lot of positive response in relation to the portability and resolution of how it plays out.

And finally on the IT side, and I guess everybody can join in here.

We're constantly looking to add to our portfolio of new intellectual properties.

And we're constantly looking at ways to expand our franchise base.

I think this year if you look in the fourth quarter with NFL Street, is a good example of expanding the franchise and adding a new IP .

There will be derivatives of existing properties; there will be new intellectual properties that we develop internally.

And there will be new licensed properties.

The answer to -- the specific answer to your question is yes, we think there are some pretty significant new licensing opportunities out there.

We're not prepared to announce anything at the moment.

But rest assured that those things exist.

And the other thing that I would add to longer-term growth is to echo Warren's comment in his prepared remarks when he talked about this business not addressing 60 percent of the world's population.

There's a huge opportunity in China, the other Asian markets, Latin America, Eastern Europe and other places around the globe.

So longer-term growth -- it's not going to be any one thing; it's going to be five or six things that drives growth for EA.

So let me put the first question a different way.

With hardware sales call it relatively flat this year, or down a little bit, the mix is certainly different than we expected.

Software sales, growth rates for the industry sustainable in 2004?

And since you brought up international sales, what do you think of the international retail environment right now, particularly the UK and Europe?

At the moment, I will take that backwards forwards.

I will start on international retail.

International retail is almost impossible to kind of give you a net average.

In general, what we've got are markets like the UK where we have got high penetration of consoles, very, very high sales of lead titles and pretty happy retail.

So in general, we have got great relationships in the UK; the business is going through the roof.

It feels really, really good.

So, not a whole lot of resistance in the retail business there.

When we get to places like Germany, there is a lesser installed base.

The level of development is probably half that on the console side versus what it is in the UK.

And that is partly an issue of public perception of gaming and it's not as educational as the parent would typically like it to be.

And that reflects itself all the way through to retail where they tend to take fewer risks on new titles, kind of on, frankly if it's PC or console.

So a little bit of reticence there.

That is starting to change.

But it is not changing in a huge way.

So far, government has been super helpful.

Japan, for some time now, has been in a recession.

The game business has not been growing in Japan.

It's lost both the installed base growth engine that can push it through the roof, and its losses are relative to wireless technology.

Not gaming technology, just cooler technologies -- cell phones, SMS messages, down loads and a variety of things consumers are doing there.

So that tends to be a tough environment.

So what I tell you is, broad scope, North America feels good and strong;

Europe feels strong and can get stronger, particularly on the continent.

Asia, in general, feels good and strong and getting stronger with the exception of Japan, which is a little bit weak.

And Tony, with regard to next year, as Warren said, we're not prepared to give any specific guidance.

At a macro -- we need to get through this holiday season so we can polish up the crystal ball.

But in a macrolevel, as I said earlier, we expect hardware price cuts.

And I would expect them in the early part of the year as opposed to the second half of the year.

And if and when that happens, that will drive software sales.

If you take a look at the industry historically, hardware price cuts drive positive increases in the software business, and we would expect that happen next year.

To scale that now is premature.

Next we'll hear from Jill Krudik of Smith Barney.

Thanks, very much.

I was hoping you could give a little bit more clarity on the gross margin side.

As you continue to transition to more in-house development, how large -- what are you targeting in terms of the overall portion of your sales mix -- will be driven by that over time?

My second question has to do with how aggressively you're going to be continuing to support the PS/2, given the longevity of these hardware platforms; as we head into the next cycle, how will your strategy be very different from the prior strategy?

And finally, you talked about three swing titles that may or may not fall into '04 versus '05.

Can you give us a little bit of clarity on what are the factors that will drive that decision?

Is it simply development time?

Or is it reaching sales targets -- is that a big factor?

Thank you.

In relation to the first part of the question, as we shared earlier, we are continuing to expand our internal studio system.

It is working for us; we're getting great titles; we're getting timeliness of delivery that is unmatched in the industry.

And we haven't driven that against an exact calculation on our margin impact.

But we know that the trend line is to continue to increase it.

In relation to PS/2 support, we will be supporting the PS/2 throughout its lifecycle.

And that will mean as a point of transition when the next generation of video games platforms come to market.

And the third part of your question --

Jill, with respect to the titles, it's really all about the quality.

You know, this is about the customer and delivering the best titles we can.

We're going to make a call when we get there.

Yes, I would add to that that every effort is going to be made to ship all three of those titles.

These are complicated software development projects; there are some important milestones occurring in the next four to six weeks; and we will keep you advised as we move through that process.

But, as always, we forecast our business as realistically as possible, given the information that we have at any point in time.

And we tend to be on the conservative side.

We'll take our next question from David Farina with William Blair.

If you look at price (technical difficulty), where do you usually see the software cuts -- price cuts?

Is it usually coincident with the hardware cuts, or just when software sales slow down?

And then secondly adding onto that, you take $10 out, what would that do to kind of your margin structure? the most profitable last , if you will.

So, I will take the first half.

So, I don't know if you recall, the beginning of the fiscal year when we provided some guidance, we said that the top titles would be at 49, and that we would see a fair number of titles at 39.

The year has turned out with everything at 49 except our title, which is 39, and that is targeted to a younger audience.

What that is about is, with pricing above 149, we're still catering to less of a price-sensitive market.

And we've got enormous strength in the quality of our titles.

So now the answer I would give you for next year, when we see 149 hardware, is the answer I gave you this year one more time, meaning we're going to start to see a split.

It will be harder to hold $49 with a large number of hardware units in the hands of consumers that paid under $149 for them, because they are more price sensitive consumers.

So we can optimize revenue better at a $39 price point with anything other than the biggest hits.

So yes, it is connected.

When you see 149 pricing, you will shortly thereafter see a start to cast around the edges for what works at 39 versus 49.

It first happens with a $49 title getting to 39 faster as opposed to waiting of 16 weeks, we might do it in 6, 8, 10 weeks.

And on the margin side, I would tell you to go back and -- if you look at the last transition, you really saw gross margins, you know, degradation in the 3 to 400 basis points sort of range.

And the reason why you don't see direct dollar for dollar fall-off is that royalties are predicated on percentage of revenue.

So they go down as do our prices.

Thank you.

One more question, if I will.

On Madden, that incredible year-over-year growth --having been a longtime Madden player, it is a pretty hard title.

I mean, how do you -- where do you find the audience to continue to grow that product?

Obviously, it's a great-looking product that has some novel features.

But it's also getting to the point where it is certainly not a novice title.

I'm going to get you to call me after the call to send some comments to the team.

But they are continuing to work to make the title and design accessible to a broad audience.

And it's a title that at the same time, has a lot of depth built into it.

So it's hard to know which part of the game you're having a hard time with.

But we can definitely hook you up with the studio head to --

It's not just me.

People I've talked to -- it is a hard title.

It's not a title geared towards necessarily a mass audience. (technical difficulty).

I just don't know how you keep growing that title, given that a tremendous amount of (technical difficulty) doing -- that's really what the question is.

First off, let me recognize your observation as being correct.

Five years ago, Madden was EA's number one title; it no longer is.

Titles like Metal of Honor and Lord of the Rings routinely outsell it, partly because of the global nature of the title.

But secondly, because they are easy to get into.

Just play calling and pass completion in Madden is difficult for a novice.

So your observation is correct.

And other titles that are more accessible have overtaken it in terms of total sales.

But the other truth is Madden is a phenomenon.

It has an enormous audience of very dedicated consumers that follow up.

And where we can get more consumers is probably more than anything out of the momentum of titles building and online.

Right now, it is just a phenomenon there.

Consumers are all over it.

And that -- if you're playing online, you have to play the leading title.

You can't play the other guy's title and get any of the communities to play, you know, one consumer against the other.

It's like you're just not part of the right party.

So we're seeing market share growth there as a consequence of people wanting to play head-to-head.

We will probably miss anybody over 40 and anybody under eight.

And frankly, the audience kind of likes it that way.

I would add to that, there's a very high percentage of repeat purchases each year on Madden, obviously.

That installed base of hardware will continue to grow.

We'll get some percentage of those new hardware owners to buy the title.

And I think we can continue to grow market share.

Even know it's extremely high already, I think we can continue to move the needle.

I think, you know, so that we all have a shot at that question, one thing that I would add is, our studios continue to make this product better every year.

John sort of referred to it.

But the quality is up year after year.

If you look even on the PS/2, since the PS/2 was launched, this title just gets better, with more features, more capabilities, this year, being online and playmaker.

Arvind Bhatia with S. W. Securities.

Good afternoon.

My question is on Sony's Playstation 2, do you think there is a potential that they could come out with a hardware bundle -- even if they don't come out with a hard price cut?

And would that not then signal more clearly that the next transition doesn't start until 2006?

And my second question is -- you talked about 60 percent of the world not being targeted right now by major companies.

But isn't it also true that in a lot of those countries, piracy tends to be the biggest issue?

So from a potential growth standpoint -- I wonder what the true potential would be for that -- the rest of the world?

I will take a stab at the first part of your question.

We fully expect to see Sony bundle software with hardware.

It is happening currently.

I expect that to continue to happen as we move through the rest the cycle.

If your question is really, do we think it's 2006?

That would be our bet at this point in time, that we would see Playstation 3 in that time frame.

But, you know, we're going to have to continue to monitor that situation between now and then.

In terms of the international markets, piracy is in fact a problem.

If we peel back our industry analysis, you will see something interesting.

The packaged goods business has been growing pretty well in markets like Korea, Taiwan and China.

But what I mean by growing pretty well -- it's been growing from very small to not quite so very small.

We have had leading market share there.

On top of that, what's happened is a very significant expansion in the online business.

It looks like it is trending to be a $3 to $5 billion business in the online gaming in the Asian marketplace over the course of the next five to seven years.

That is a very significant shift from where things have been.

That seems to have occurred because local players in the marketplace have not been able to build a packaged goods business because of the piracy.

They are using online to get around that problem by basically setting up client/server games where, even if you stole the software, or pirated the software, you have to pay to play it.

And they are using phone payment card systems; they are using prepurchased time.

They are using a variety of different mechanisms that make it harder to pirate.

So it seems that they are getting around the problem with the new -- especially the new platform and a new pricing approach.

And we are dialing our efforts up in that area precisely because we see the opportunity.

I guess on the PS/2, Larry, I was alluding to maybe a new bundle approach;

I know they are doing a bundle right now, but something more substantial over the next few weeks or so.

It could happen.

We don't have any information about that.

Okay.

Then could you tell us what the catalog was as a percentage of sales this quarter?

27 percent in the quarter.

William Lennon Jr. with WR Hambrecht.

First two quick housekeepings.

Thanks for that catalog question.

I was wondering if you could also, if you have it handy, tell us what catalog was last December?

I don't know if you ever said that in the last conference call.

Second housekeeping item, Warren, did you give the European software ranges that you guys normally give U.S. and Europe?

And if I missed that, I apologize.

The first answer to your question is 35 percent a year ago.

In the September quarter.

35 percent in September last year?

Yes.

Do you happen to have last Christmas handy?

December?

We can grab that for you if you want to give us a ring back.

Then I'm sorry, the second question?

Yes, actually, a second housekeeping, then I had a couple of real questions.

The ranges on software growth you gave earlier.

If you gave Europe separate from the U.S., I must've missed it;

I think you normally break it out, and I only have U.S. written down.

Could you give us the Europe ranges again?

You know, what we've said in the past is, they will be in the same range as the U.S., which is slightly higher.

Okay.

And then I had a couple of quick ones.

For the PC games environment, in the Christmas quarter, you've talked about demand, you've given a range of the addressable market going down.

What's your assessment of the supply -- both number of titles -- not just yours -- everybody's coming to market -- and quality that you're competing with.

Second question is, retailers are showing middle of December, like the 15th for the Sims Bustin’ Out.

Is that accurate, or is that coming a bit earlier in December?

Let me take the first part.

One of the reasons that we adjusted the outlook on PC is because a couple of key titles from competitors have moved out of the calendar year, specifically Dim 3 and Half-life, which I think publicly announced to ship in calendar '04.

So we think that brings down the overall PC category.

Now with that said, our PC business is tracking very nicely, and we are continuing to build market share, and we are pretty happy with our performance.

Bustin’ Out is the fifth of December.

Paul Tryon with first Albany.

I had a question on the SKU count for the year.

Is it, now looking to use more like 95 to 100; is that accurate?

That's a fair statement.

Okay.

Looking into Q4, you didn't mention James Bond as a swing title?

That is correct.

Okay.

Thanks.

I have no more questions, thanks.

And we'll take our next question from Keith Gay with Thomas Weisel.

Hi.

You say it looks like the holiday season will be a lot like last year.

But can you comment on that in terms of what you expect in terms of the sales space allocation this year versus last, particularly facing the big box retailers and with no Vice City, as you mentioned before, does that perhaps give you the opportunity for more space?

At big box retailers, the top 10 titles usually get well over half of the space.

We would expect to have four out of the top 10 on the PS/2 in comparable ratioed out against PC and other platforms.

So PS/2 will be the lead dog at retail.

We'll get four out of 10 of the top 10 this quarter, meaning that we will be the leading publisher on the shelf.

And of course, we get a little bit more out of our sales force given some of the historical strength we've got; so it will probably be a little better now.

With no Vice City in the market, I think that gives titles like Metal of Honor, Lord of the Rings, Need for Speed, our sports titles, more opportunity to sell more units.

And so, I would predict that our market share in the holiday season this year is ahead of where it was last year.

Because there isn't that title to compete with.

And the other one I would add to the list is SSX 3, which is getting rave reviews prior to release -- just in release, actually.

And a couple of questions about online, especially EA SPORTS Nation -- you've been adding 30,000 a week.

Further thoughts on monetizing that ad as well as -- I think we are seeing some pretty good numbers in terms of the amount of time spent online.

But, what does that mean in terms of cost of supporting versus eventually leading to monetize that area?

And then one final question I guess, just on the swing titles -- if those titles were to come in FY Q4, is your guidance incorporating that, basically if that would be upside?

I will let Warren mull that last one over for a while I talk about EA SPORTS Nation until he figures out an answer.

In terms of EA SPORTS Natin, we have got about 350,000 registered consumers.

And yes, they're spending a lot of time online playing.

It is starting in the -- in our current quarter, we are beginning the process of monetization of that audience; but it is frankly a modest effort.

What we are doing is we're starting pay to play tournaments.

What we're trying to do is learn and also communicate to this community that it is not going to be free forever.

The challenge is making sure that we actually have something worth paying for, and don't charge them for something they would otherwise think is free.

So, I think probably two calls ago when this came up, we described this year as a business more like a hobby, and it is a real business in the next generation.

You'd also asked a little bit about how this is affecting the cost structure with all these people online and playing.

The answer to that question is, our current circumstance, with PS/2 online is that it is essentially a fixed cost.

You know, most of the playing is actually peer-to-peer.

We have got a certain number of people providing support.

And we are running leader boards and other things that are relatively inexpensive.

Eventually, what we try to do is marry the revenue opportunity and we're looking at some greater investments there.

It is helping us on market share.

We do talk online.

Pogo has done really well.

We frankly have been surprised by the uptick we've had in paying subscribers there.

That gives us an indication that some of the things that we do for monetizing that audience we figured out correctly, and that is growing pretty quickly.

So we will give final there to our SPORTS Nation and the EA GAMES Nation, going forward.

And as for the second question, I think we'll just leave things right where they are.

We'll tell you, these titles could go either way; we'll report as we move along.

And we think our guidance is appropriately conservative.

Okay.

Thank you.

We will time one more question, operator.

Our final question will come from Stewart Halpern with RBC Capital Markets.

Thank you for taking the question.

First, a clarification.

Did you actually say that your expectation is for calendar '04 hardware units to exceed calendar '03?

The statement we made was that it could.

We're going to obviously watch over the coming weeks and months and see what happens.

But that possibility is certainly out there.

And I think that depends on how severe a price cut and when it happens.

Okay.

Then, just a question on -- your cash was up sequentially about 100 million-ish; interest income up 5 million-ish; that seems disproportional.

Is there something else that went on in the other income line there?

There was a slight foreign exchange benefit of 2 to $3 million.

Got you.

Just finally, you're talking about the long-term international opportunity in some of those markets that aren't currently meaningful.

Do you have any perspective as to when you think those would start becoming truly meaningful?

First off, our Asia business, excluding Japan, so the developing markets in this part of the world, they will be around $100 million business.

That's not lacking meaning ; but it is not a significant portion of the total.

What we need to start to see happen, and I believe we will in the coming fiscal year, is higher growth rates coming out of that.

But just higher growth rates alone aren't going to turn it into a quarter of our business for five to seven years.

And that's probably the time frame for when it looks like it has the potential to be, you know, maybe where Europe is today.

So, it's going to take, short of acquisition or something, which I'm not pointing you to, and just pushing out organically, I would say five to seven years.

The other think you're going to have to see is the hardware companies, like Sony, Microsoft and Nintendo, making more concerted effort in those markets.

I think you'll start to see that happen relatively soon.

And so part of that directional growth will in fact come from sort of -- whether it's politically or otherwise -- crackdowns on piracy.

So you're not expecting all of that to really come from that online model you're talking about before?

Some will.

But I think the issue is online plus counsel.

Console isn't pirated anywhere to the degree that PC software is.

Okay.

Thank you.

Thanks, everyone, for joining us.

That does conclude our conference for today.

We thank everyone for their participation.

And we hope you have a great day.